Emergence of manufacturing hubs in India

26 February 2005

The following is the text of the speech that Mr. Kumar Mangalam Birla delivered at the India Today Conclave held in New Delhi on 25 and 26 February 2005.

Let me begin by thanking Mr. Aroon Purie and the India Today Group for inviting me to this conclave, and for the opportunity to share my thoughts with you. Over the last four years, this conclave has come to be recognized as a very important platform for the discussion and dissemination of significant ideas of both national and international relevance. This year's theme of 'Perception and Reality' is an apt theme for looking at emerging India.

The good news is that the gap between perception about India and reality seems to be surely narrowing. A Google search, though an admittedly unscientific test, reveals over 10 times more references linking 'India' and 'China' than 'India' and 'tiger' and 100 times more than 'India and Maharaja', than even three years ago. And, I have no doubt that this conclave's deliberations will further help dispel many an illusion about the Indian economy!

The question posed by the topic of this session, "Can India be a global manufacturing hub?" entails a gaze into the future. I think it was Yogi Berra, the legendary baseball coach who said 'Prediction is hard, especially about the future!'. However my task today is made much simpler, since the trends and data before us suggest a vote in the affirmative for India as a manufacturing hub. But before talking specifically about the India story let me focus briefly on some of the important global trends in manufacturing.

The changing face of manufacturing

Manufacturing hubs emerge due to a process of agglomeration. Because of agglomeration a disproportionate surge of manufacturing is attracted to locations with a lower wage cost or higher market access or both. Thus when textiles manufacturing shifted from the US North East to the US South, then to Japan, Korea and now finally to China and India, it fits a predictable pattern. The same is true when the auto industry shifted from Detroit to Mexico across the border and Brazil, and then again to South East Asia.

The shift of manufacturing from West to East is evident in industry after industry. For instance, nearly two-thirds of world fiber production comes from Asia today, the same as the share of North America and Europe in 1980. Reflecting the shift in production bases, nearly one-fourth of the world fuel demand now originates in non-Japan Asia, compared to just one-tenth in mid-seventies. To take a more recent example, China, Thailand and India have contributed to 36 per cent of the increase in world vehicle production between 2001 and 2004. China itself now accounts for one-fourth of the global steel and aluminium demand, nearly one-third of the coal demand and 40 per cent of the cement consumption.

During the past 30 years the weight of global GDP has been progressively shifting away from North America and Europe toward the ASEAN region. The share of OECD Europe has declined by 5 per cent, and that of the US and Japan by 1 per cent each. The average GDP growth of China and Korea over the past 23 years has been 9.5 and 6.7 per cent respectively. Even Taiwan, Malaysia and Vietnam have had impressive six plus per cent growths. India's growth story is well known. The point I wish to emphasize is that incremental GDP and incomes are rising much faster in Asia, which means incremental growth in demand for all kinds of manufactured goods will arise substantially in this region. India's location, amongst its other strengths, makes it ideally poised, along with China, to take advantage of this growth in regional demand.

Despite concerns that the importance of manufacturing is declining at the global level, the global share of manufacturing in GDP is still close to 25 per cent. Again, this share is much higher for the fast growing developing economies of Asia, which bodes well for us, although on the whole, globally much of the MVA (manufacturing value added) still comes from the developed world. The share of global MVA has however declined from 85 to 75 per cent for developed nations, while for developing nations it has gone up correspondingly from 15 to 25 per cent. In India itself, the share of MVA is about 17 percent of its GDP, much lower than our peers in East Asia, which indicates substantial headroom for growth.

So a closer look at this global picture shows that manufacturing is not at all declining at the global level. There will be large opportunities for those who can fit into the shifts that manufacturing is undergoing. And the opportunities are especially exciting for our part of the world.

Let me now present the case for emergence of manufacturing hubs in India. I ask you to look at three determinants. First is the phenomenon of inflection - i.e. non-linear growth signifying take-off for the Indian economy. Second is a set of some emerging trends that are going to favour India. And third is the set of imperatives in the context of India's own development needs, which will propel us toward boosting our manufacturing sector.

Firstly, let us talk about the phenomenon of inflection.

India's inflection phenomenon

With its size and rate of growth, India has the critical mass today in many sectors. For many commodities, India has become either the largest, or amongst the largest producers in the world. This includes two wheelers, cement, steel, generic drugs, laminated tubes and polyester fiber. Ninety per cent of the world's diamonds pass through India in their value adding chain - from uncut stones to polished gems. On a more micro level, there are many global-scale achievements. To mention only a few, the world's largest motorcycle (Hero Honda) and maker of CD-ROMs (Moser Baer) are based in India. One of our own companies has the world's largest, single-location copper smelter and is located in India. Even in the new industrial - and scientific - field of satellite launching activity, an Indian firm is counted among the top six in the world. Twelve Deming Prize winners - regarded as being equivalent to the Nobel Prize for manufacturing - are from India. The short message of all these achievements is that India can legitimately aspire to be a global hub. It's not a far-fetched target. Rather it's an ambition based on a proven track record.

There is now also sufficient evidence to suggest that the trajectory of India's growth will be on a distinctly higher level for decades to come. There was a trend break from the past, sometime during the 1980's, which has caused the trend growth rate to be closer to 6 rather than 3.5 per cent seen in the first three decades after independence. This trend now spans almost 25 years, a period comprising 7 parliaments, 10 prime ministers and 12 finance ministers, clearly pointing to some growth resilience. (That is not to deny that government policy can still facilitate higher growth). Per capita incomes are also growing much faster owing to deceleration in population growth. All this will have dramatic and profound implications for the Indian people and for Indian business, and hence, for the manufacturing sector as well.

According to some calculations, assuming an average annual growth rate in India's GDP of 5 per cent over the next few decades, its GDP will double roughly every 14 years. Today's GDP adjusted for purchasing power parity of 2.95 trillion dollars will become 24 trillion dollars in 2047. American GDP which is currently 12 trillion dollars would - at an assumed average annual growth rate of about 2 per cent - have merely doubled to 24 trillion dollars by 2047 - the same as India. Thus in just over one generation, India's GDP could well surpass America's GDP to become the world's second largest economy after China, whose GDP then, according to these calculations, would be 32 trillion dollars.

However, linear projections such as these, sometimes miss out on the characteristics of an economy that is at the take-off stage, which is perhaps where India stands now. After per capita GDP reaches a certain threshold, higher purchasing power kicks in and growth tends to accelerate. An example of such a remarkable transformation is South Korea, which graduated from a less-developed country (LDC) to an OECD member, within a span of about three decades.

The potential for India to develop as a manufacturing hub ties in closely with this phenomenon of inflection. As has been the experience of other countries, the break in the trend line leads to accelerated domestic growth, increases in disposable incomes and sharp increases in domestic demand. The booming domestic market drives the build-up to a critical mass of manufacturing - that a global thrust calls for.

Yet another factor that will reinforce this dynamic is demographics. Demographic trends are in India's favour. Populations in economies like Europe and Japan have already begun to age. On the other hand, it is projected that India in 2050 will have the largest number of young people below 25 years in the world, over 550 million and the largest number of people in the productive age group of 20 to 60 years - 800 million. Global trends are such that large investible pools of capital - in countries with ageing populations - will need to be invested in high growth regions with a large need for capital, India among them. Incidentally, labour shortages in the developed economies will continue to drive the flow of labour-intensive services - from places like India.

The confluence of these factors - reaching a take-off point, favourable demographics, and complimentary between countries in labour and capital availability and requirements - contribute to the inflection phenomenon.

What substantiates this view is that many of India's world-scale achievements are of recent vintage, and the ramping up has been rather steep, reinforcing the inflection belief. For example, starting from zero, within a few years we now export about 4 billion dollars of refined crude - mostly as petroleum and diesel. We have gone from zero to almost a billion dollars of production and export of copper. The R & D activities of many global majors - among them IBM, Microsoft and GE - are being ramped up in India. The speed of the telecom spread in India has been breathtaking - a fact that has made even some policymakers admit that they underestimated the market potential. The growth in automobiles and auto ancillaries also has been exponential.

These examples reinforce my belief that the inflexion phenomenon is bound to take Indian manufacturing on to a higher plane in the coming years. It is, therefore, time to stop thinking in linear and incremental terms and dream really big.

Let me now shift the focus briefly on two important emerging trends that give India an edge in becoming a manufacturing hub, and spell 'Advantage India'.

Fundamental trends advantageous to India

The first trend is the increasing openness of the Indian economy. I use the term as understood by economists - i.e. increasing ratio of traded goods and services to GDP, which for India is close to 28 per cent. Our current openness is higher than that of the U.S., for whom it is 23.1 per cent. In this increasingly open environment we have seen a lot of firms flourishing by using a combination of cost-cutting and nimble innovation as well as aggressive marketing. Microeconomic data shows that for the past few years, for a large cross-section sample of firms, the rate of growth of export income is faster than the growth in total sales or even profits.

Not just have exports grown at close to 20 per cent per annum in dollar terms, but their composition has also shifted away from primary materials, to more valued-added merchandise, such as chemicals, engineering and textiles.

The second mega trend is that of outsourcing. What started off as a trend applicable only to IT and IT-enabled services, is rapidly embracing auto components, even autos, engineering design, pharma research, clinical trials, and also a variety of services. This will further enable the move to building global scale industrial activity in India. There seems to be nothing that cannot be outsourced to India. They used to say, that some services simply cannot be exported, like say cheap haircuts. But, in a lighter vein, I think the day is not too far away, when Indian barbers wearing cyber-gloves sitting in cyber-cafés in Mumbai, would be giving their American brethren low cost haircuts - call it low tech tele-surgery!

All these trends bode well to for us to aggressively scale up manufacturing in India to serve both domestic and overseas markets.

I now add another driver for the manufacturing hub story. This factor is related to the imperatives of India's own developmental needs.

What are the imperatives for a manufacturing thrust for India from an economic point of view

The imperatives come from many angles. The first is our development strategy. A high and sustained growth rate of 8 per cent is the surest way to raise a large proportion of people out of poverty. And this high rate cannot be sustained by relying solely on agricultural or services growth. Due to inherent natural constraints on agriculture, the best growth rate that we can hope for (which will be marred by occasional monsoon failures), is about 3 to 4 per cent. The services sector cannot wholly grow at very high rates, since almost half of it is in the form of provision of government services. Hence, the manufacturing sector has to be a critical locomotive - and it needs to grow at close to 10 or 12 per cent, so that the economy as a whole maintains a growth of 8 per cent.

The second imperative is demography. We all know that for the foreseeable future, India's labour force will grow faster (at 2.5 per cent) than its population (at 1.6 per cent), as more youth, and more women enter the labour force. This expansion in the labour force cannot be absorbed by the agriculture sector alone, given the chronically low productivity in this sector. One-fifth of the national output i.e. agriculture, is produced by two thirds of the labour. This is clearly unsustainable. Manufacturing thus has the potential to make a sizeable dent in unemployment, and also in the process improve productivity. Industrial wages and productivity are higher, often by a factor of five. So, in order to turn the demographic opportunity into a demographic dividend, we have to create jobs in manufacturing. It's a Hobson's choice.

The third imperative comes from resource considerations. On minerals, metals, fuels, we have been generously endowed by providence. We have a large land mass - and our population density - notwithstanding our high population is only half as much as say, the Netherlands. While we have to be careful about not depleting our environmental capital, our economy and ecology can support substantially higher levels of industrial activity.

The fourth imperative is that of attaining cost leadership. India is amongst the lowest cost producer for many industrial products. Our overall cost leadership is driven by the advantage in labour costs, and this will sustain well into the future given a pragmatic policy climate. We also have special human capital strengths in engineering and science, and this highly skilled labour costs much less than its counterpart in Europe or the U.S.

So if I have persuaded you that India's growth inflection and its own development imperatives mean that we seriously look at building global scale in manufacturing, let me hasten to add that this growth story comes with some important caveats. Let me focus on what I believe are the three most critical ones.

The way ahead

Policy Climate

I have said earlier that hubs emerge due to an advantage of labour cost and resource availability. But what can seriously hinder or facilitate this process is the policy climate. So, first, what about our policy climate needs to change to make it more investment friendly?

Economic policy making is an evolving process, often experimental, or innovative. Sometimes, policy makers can make mistakes but course corrections are possible. India's telecom policy is a good example of how a relatively quick mid-course correction, of shifting from fixed licence fees to a revenue sharing regime, gave a huge boost to the industry, investment and the economy. By contrast, electricity liberalization, which began earlier than telecom, has been unable to change course or attract large investments. Singapore is an outstanding example of nimble shifts in policy that recognized economic realities and bolstered growth. So the ability of policy making to create a big impact is linked with how fast policies can be adapted in sync with ground realities.

Also, as things stand today a significant amount of policy-making is centred around the budget, which can be for many a make or break event. Our annual budget is always preceded by nail biting suspense. In few other countries is the budget such a watershed event. For instance, in the South East Asian countries where we operate, the budget is essentially a statement of government accounts. The key policies affecting business and industry are articulated for a period of at least five years, and are not subject to annual budgetary shocks, as in India. The result is that businesses are able to operate under conditions which are stable and more predictable.

Hence, if we are to plan big and think global, then we definitely need to have a stable long term policy framework, that enables businesses to commit large resources with much greater certainty.

Second, infrastructure remains the most critical bottleneck. Let me just mention two areas - power and ports.

A detailed survey by the World Bank has found that manufacturers in India face nearly 17 significant power outages per month, versus only one per month in Malaysia and 4 in China. Nine per cent of the total of output is lost due to power breakdown, compared to 2.6 per cent in Malaysia and 2.0 per cent in China. Moreover, India's combined real cost of power is 74 per cent higher than Malaysia's and 39 per cent higher than China's.

Our port infrastructure also remains very inadequate. While building global scale means goods need to be exported all over the world, India's goods cannot be pushed through the bottleneck of the ports. India's 12 major ports handle only about 30 million TEU traffic, while the need is probably close to 100 million. The traffic capacity of Singapore or Hong Kong is at least four times the largest Indian port. The turnaround time for ships docking at Indian ports is worse by a factor of 10, compared to our East Asian peers. Many large Indian exporters have had to build and operate their own jetties to overcome these constraints. This is a handicap that is tough to neutralize in a cost-competitive world.

Our own copper story is worth mentioning. More than 20 per cent of our initial project cost went toward building a private jetty, a captive power plant, and a 70 kilometre water pipeline. This infrastructure is taken for granted in most developed economies, and also in most of our East Asian neighbours. Despite these cost loadings, we have been able to hold our own, and are globally rated in the top quartile in cost efficiency.

And, third, let me emphasize the last-mile issue of implementation. Plans, policies are only as good as the speed with which they are executed. We need to put a much higher premium on speed of decision making as well as implementation to enable projects get off the ground and reach fruition at the earliest. This is particularly true for FDI. More often than not, investment remains thwarted for lack of speed in getting approvals.

Conclusion

In conclusion, it is the responsibility of both corporations and policy makers to ensure that India does not miss the bus. India's roadmap to becoming a manufacturing hub will have to be based on the building blocks of global vision, a passionate mindset about manufacturing, focus on value-enhancing innovations and a facilitating business climate.

While it may be difficult - and even impractical in an operational sense - to conceive of making a country competitive across all sectors, we can definitely work out and implement a strategic blueprint to make industrial sectors and/or clusters competitive.

What eventually will clinch the issue in India's favour, I believe, will be the 'never say die' attitude of Indian entrepreneurs. On more than one occasion, we have proved the cynics wrong, by bouncing back strong, in-spite of the severity of the constraints.

And, India's economic history has always been marked by home-grown entrepreneurship which goes back more than 100 years. The way Indian businesses respond - even under constraints - is nothing short of astonishing. India - and Indians - would be right - and justified - in terms of dreaming big - to become a global manufacturing powerhouse, and it is this indomitable spirit that will succeed in taking India to the world.